Bond Gains Falter as Fiscal Cliff Threatens U.S.: Credit Markets

By Charles Mead -
Nov 26, 2012

The biggest rally in three years in corporate bonds from the U.S. to Europe and Asia is losing steam, with the debt poised to deliver the first monthly losses in a year as the fiscal cliff imperils America’s economic recovery.

Declines in the debt of firms from Wal-Mart Stores Inc. (WMT) to Anheuser-Busch InBev NV (BUD) are depressing global returns in November, with a 0.045 percent loss this month, paring gains since year-end to 10.93 percent, according to Bank of America Merrill Lynch index data. Losses in the U.S. total 0.42 percent this month.

Corporate earnings are being threatened as Washington lawmakers struggle to avoid $600 billion in scheduled spending cuts and tax increases that the nonpartisan Congressional Budget Office said may push the world’s largest economy back into recession. A rally that’s averaged 11 percent in annual total returns since the end of 2008 is also unlikely to be sustained with yields already the lowest on record, according to Legal & General Investment Management Ltd.

“There’s genuine skepticism across the markets that we’re going to get a real grand bargain to resolve the fiscal cliff,” Edward Marrinan, a macro credit strategist at RBS Securities in Stamford, Connecticut, said in a telephone interview. “We’ve reached a point where I think market participants have concluded that the upside was being steadily squeezed out of corporate credit.”

End Heralded

The extra yield investors demand to hold bonds from the most creditworthy to the riskiest borrowers has widened this month for the first time since May, expanding 3 basis points to 232 basis points, or 2.32 percentage points, according to the Bank of America Merrill Lynch Global Broad Market Corporate & High Yield Index. Spreads reached 238 on Nov. 16, the widest since Oct. 4.

“It’s heralding the end of what has been a very sustained and very strong rally,” Georg Grodzki, the London-based head of credit research at Legal & General, which manages $622 billion of bonds, said in a telephone interview. Gains are “returning down to Earth, with maybe a bit of a bump, but it was inevitable that spreads could not tighten and yields could not compress forever,” he said.

Amazon, MBIA

Elsewhere in credit markets, Amazon.com Inc., the world’s largest online retailer, is planning to issue debt in its first dollar-denominated offering in more than a decade. MBIA Inc. bought back $170 million of notes and got enough support from bondholders to complete a debt amendment that shields itself from being dragged into bankruptcy by a cash-strapped unit.

The Markit CDX North America Investment-Grade index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, increased the most in more than three weeks, climbing 3.4 basis points to 102.4 basis points as of 11:43 a.m. in New York.

The indexes typically rise as investor confidence deteriorates and fall when it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million.

Amazon’s Return

Amazon, which has no bonds outstanding, is planning to sell $2.5 billion of debt, Moody’s Investors Service, which assigned a Baa1 rating to the notes, said in a statement today. The debt will be sold in three parts maturing in three, five and 10 years, according to a person familiar with the offering who asked not to be identified, citing lack of authorization to speak publicly.

Amazon last sold dollar debt in 1999, raising $1.25 billion of 4.75 percent, 10-year convertible notes, according to data compiled by Bloomberg. Proceeds from the offering will be used for general corporate purposes, including the purchase of Amazon.com’s corporate headquarters for $1.16 billion, Moody’s said.

MBIA said a majority of investors holding almost $900 million of bonds approved changes to indentures that would have accelerated payments if its MBIA Insurance Corp. (MBI) subsidiary were to be seized by regulators. To gain enough bondholder support, MBIA repurchased about 52 percent of its outstanding 5.7 percent bonds due in December 2034, which Bank of America Corp. had offered to buy on Nov. 13 in an effort to block the changes.

More Stable

The changes allowed the insurer to replace MBIA Insurance in the so-called cross-default provision with its more stable National Public Finance Corp. that holds the insurer’s state and municipal bond guarantee business.

MBIA paid consenting bondholders $10 for each $1,000 in face value. Bank of America had said it would pay par for the 5.7 percent notes if they were tendered by Nov. 27, and $950 per $1,000 of face value between then and Dec. 11, conditioned on a majority of the notes being tendered, according to a Nov. 13 statement.

Corporate bonds are facing losses after more than doubling the 4.9 percent gain in all of 2011 and exceeding the 8.5 percent received in 2010, Bank of America Merrill Lynch index data show. Returns this year are second only to 2009 when bonds gained 20.52 percent, the most on record, as the market began to revive from the worst financial crisis since the Great Depression.

The debt last handed losses in November 2011, with a 1.98 percent decline.

‘Overwhelming Factor’

While bonds of non-U.S. issuers have gained 0.27 percent this month, declines in $3.9 trillion of American securities has weighed on global returns.

Fixed-income investors are concerned that U.S. policy makers won’t agree to a solution that would avert the fiscal cliff after President Barack Obama, a Democrat, was re-elected this month with Republicans retaining control of the House of Representatives. The U.S. will probably tip into recession next year if lawmakers can’t break the impasse, the CBO said in an August report.

“The fiscal cliff, and what there’ll be in terms of drag on the economy, is the overwhelming factor,” John Donaldson, director of fixed income at Radnor, Pennsylvania-based Haverford Trust Co., said in a telephone interview. “If that happens, an almost assured weaker U.S. economy is not very good for corporate margins, profits and cash flow.”

While profit and sales growth in 2013 among firms in the Standard & Poor’s 500 index is expected to exceed this year’s performance, nearer-term forecasts signal a decline, Bloomberg data show.

‘Enough Uncertainty’

Profit growth is expected to fall to 1.6 percent in the first quarter of next year, from a projected 4.3 percent increase in the last quarter of 2012; revenue growth may drop to 2.1 percent from 3.1 percent.

“At this stage in the game, there’s enough uncertainty about the direction from here that people are going to focus on the next quarter or so rather than on the whole-year outlook,” Kathy Jones, a fixed-income strategist in New York for Charles Schwab Corp., which has about $1.9 trillion in client assets. “There’s probably a fair amount of fund managers just taking money off the table.”

Modified Duration

Randy Hargrove, a spokesman for Bentonville, Arkansas-based Wal-Mart, and Karen Couck of Leuven, Belgium-based AB InBev declined to comment on the declines.

Average bond prices that reached a record-high 110.3 cents on the dollar on Nov. 8 signal little room for more benefit from capital appreciation, saidMarrinan of RBS. Future returns will come mostly from coupons that have declined to the lowest levels ever, he said.

“For these past three and a half years, credit’s been on a tear,” Marrinan said. “As we look into 2013, there’s frankly almost no legitimate chance for meaningful capital gain at current yields and spreads.”

Average yields on the $8.8 trillion of global company bonds of all ratings had declined 144 basis points this year to a record-low 3.38 percent on Nov. 8, before ending last week at 3.44 percent, Bank of America Merrill Lynch index data show.

The drop in yields has helped boost modified duration, a measure of the securities’ price sensitivity to yield changes, to an unprecedented 5.73 at the end of October, signaling a 100 basis-point rise in yields would cut bond prices by almost 6 percent.

“They had a good run, but there has to be a point where that run stops,” Jody Lurie, a corporate credit analyst at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview. “A lot of investors are reassessing now, and are thinking, ‘All right, we’ve gotten all we can; the juice is almost out of it.’”